The idea in brief:
New Australian laws commence on 1 July 2018 which render unenforceable all rights in commercial contracts that are triggered upon:
- the other party having a receiver or administrator appointed,
- the other party flagging an intention to pursue or making a court application for a compromise or scheme of arrangement with its creditors to avoid a liquidation, or a reason that relates to this event,
- the financial circumstances of the other party before or during the above receivership, administration or application/announcement to pursue an application in relation to a scheme of arrangement with creditors to avoid liquidation.
The types of contractual rights that will now be unenforceable in response to the above events are wide ranging and include, for example, a right to call upon a bank guarantee, suspend the contract, vary or terminate a contract solely because of one of the above events or circumstances.
The laws are part of the Australian Federal Government’s Science and Innovation agenda. The Government states they are required to assist shift Australian corporate culture from what is currently viewed as one of risk avoidance and shame associated with failure, towards more of an entrepreneurship and innovation driven culture.
The law applies to all contracts (with some limited exceptions presently contained in draft regulations) and the Government has power to regulate against any drafting attempts to circumvent the laws. Examples of some of the draft exceptions that the laws will not apply to include: derivatives contracts, contracts for the underwriting or issuing of or sales of securities, business sale contracts (including by way of sale of shares in the business) and some specific clauses are exempted from application of the new laws, including set-off clauses.
The law applies to ‘self-executing clauses’ in contracts (i.e. clauses in contracts that automatically apply upon one of the now protected insolvency events occuring, without either party needing to decide or do anything to exercise the right) and the Government has power to exclude certain clauses from this law by ministerial declaration, in order to promptly deal with any unintended consequences.
So what should you do in response?
- Carefully vet (even more so than presently) the financial strength and perceived future financial security of all counter parties before entering into significant contracts from 1 July 2018.
- Amend your existing standard contract terms to strengthen other termination rights, particularly where the other party fails to perform or meet contractual obligations.
- Be cautious when considering proposed amendments to termination rights in commercial negotiations. They could be important rights you need to rely on later.
- Review all clauses in your contracts which are triggered or dependant on an insolvency event and consider (by seeking advice from a firm like ours) how that clause and the risk it addresses may otherwise be practically or legally managed.
- Increase diligence and ensure careful contract administration of your important commercial contracts. This will be important for reasons discussed below post the new laws commencing.
- If your contractor or supplier does become insolvent or has an administrator or receiver appointed, do not call on bank guarantee security, exercise another right or purport to terminate the contract without seeking legal advice from a firm like ours.
- As the reforms will only apply to contracts entered into on or after 1 July 2018, if possible, consider varying your existing contracts to include new work/services rather than entering into new contracts with the same suppliers shortly after 30 June 2018.
- Train contract administrators and non-legal staff about the application of these new laws to ensure no unlawful steps are taken to terminate or exercise rights which are unenforceable post 30 June 2018.
Why? A detailed explanation of the law, and each of the above recommendations appears below.
The idea in detail:
The Australian Government recently passed new laws as part of its ‘National Innovation and Science Agenda’ which effectively renders unenforceable certain types of ‘ipso facto’ clauses.
Ipso facto clauses are types of clauses typically included in commercial contracts that allow one party to exercise a right under the contract upon the occurrence of a specific event (e.g. a right to terminate the contract if the other party becomes insolvent, or has an administrator or receiver appointed), regardless of whether the counter-party is performing the contract according to its terms.
The Government claims that the laws are needed because current insolvency laws place too much emphasis on ‘stigmatising and penalising failure’. The laws are an effort to shift Australian corporate culture from risk avoidance and shame associated with failure, to entrepreneurship and innovation. The reforms are also expected to give companies greater control over their trading during an insolvency event or restructuring and assist in preserving the business as a going concern capable of sale or recapitalisation.
The law provides that any contractual rights that are triggered on:
- the appointment of a receiver or controller to all or a substantial part of a company’s (or other body’s) property
- the appointment of an administrator to the company (or body)
- a company (or other body) applying or announcing an intention to apply to a court for a scheme or arrangement with creditors to avoid liquidation; or
- the financial position of the company (or body) before or where any of the above events occurs
cannot be enforced, following the occurrence of any of 1-3 above for 2 ‘stay’ periods.
The first stay period, preventing the enforcement of contractual rights, operates for an initial period as set out below and then a second indefinite stay period after that applies to ensure that after the insolvency event has passed, it cannot be used as an historical reason for termination (which would defeat the purpose of the first suspension):
|
Insolvency event |
Period of first stay |
|
Receiver appointed |
the stay will begin when the receiver is appointed and ends when the receiver’s control ends |
|
Court application (or announcement of intended application) for a creditors scheme of arrangement |
the stay will begin when the announcement/application is made and ends: (a)3 months after the announced application if no application is made by then, (b)when the application is withdrawn or dismissed by the Court, (c)when any compromise/arrangement is approved, or (d)when the company is wound up. |
|
Company under administration |
the stay begins when the company comes under administration and ends on the later of the end of the administration or the company being wound up. |
During the first stay period, the law also provides that the company in financial difficulty cannot enforce any contractual rights it has to receive further credit or advance of money from counter parties under its contracts.
Courts are empowered under the new laws to make orders staying the enforcement of other contractual rights which are not already unenforceable under the new laws following one of the above events, if the court is satisfied that those other clauses are likely to be exercised because of the above protected insolvency events. A practical example of this may be an administrator applying to the court for an order declaring that termination for convenience clauses be declared unenforceable for a period. Where the court is satisfied that a threat exists that parties may exercise rights to terminate the contract under the termination for convenience provisions because of the appointment of the administrator, indirectly circumventing the new law, the court could declare those clauses unenforceable for a period.
The administrator, scheme regulator or receiver can consent to the exercise of rights deemed unenforceable under the new laws.
Finally, the Minister can declare certain specific rights enforceable by Ministerial declaration, notwithstanding the new law. This is to allow the Minister to quickly relieve any unintended consequences of the new law.
So, what should you do in response to the new laws and why?
|
Response |
Why? |
|
More carefully vet the financial strength and future prospects of counter parties before entering into significant contracts from 1 July 2018. |
You will more than likely be stuck with your contractual counter party if they suffer financially difficulty unless you can prove some other performance-based breach of contract sufficient to entitle termination under the contract. Practically, this may be difficult to do until their performance deteriorates or they stop performing which will be time consuming. Prevention is always better than cure. |
|
Amend your existing standard contract terms to strengthen termination rights, particularly where the other party fails to perform or meet contractual obligations. |
The law does not prevent termination for reasons other than one of the protected reasons, provided it is not in substance a termination because of the protected reasons. This means it will be increasingly important to ensure termination rights for other breaches or performance triggers based entitling termination remain available. This may prove the swiftest way to terminate a contract with an insolvent counter party rather than waiting for performance to deteriorate enough to warrant a breach notice, cure period and then termination step. |
|
Be cautious when considering any proposed amendments to termination rights in commercial negotiations |
These clauses if they afford strict rights to terminate for performance reasons may be crucial to rely upon in the event of financial failure of the counter party given your right to terminate immediately due to usual ‘insolvency events’ alone will no longer be available. |
|
Review all clauses in your contracts which are triggered or dependant on one of the now protected insolvency events, and consider how that clause and the risk it addresses might otherwise be practically or legally managed. |
Every contract is unique. Some contracts contain rights to call on bank guarantee or withhold payment or suspend performance or other rights if the other party is subject to one of the now protected insolvency events. It is important now, given the new laws, that those rights are reviewed because most of them are no longer going to be enforceable upon one of the protected insolvency events, unless exempted by regulation. |
|
Increase diligence and careful administration of important commercial contracts. |
This will ensure any right to terminate for breach or poor performance remains open to you and is not clouded by relaxed administration of the contract or a waiver of rights by conduct. Termination of contracts when another party is insolvent will from 1 July 2018 largely depend on proving a breach entitling termination or the existence of another right to terminate that is not reliant on the now protected insolvency events. This is often not a simple exercise, particularly where the performance of the counterparty is off-site (such as in supply contracts) and progress of contractual performance is difficult to objectively discern in a way cogent enough to support breach and the serious step of termination. |
|
If your contractor or supplier does become insolvent/has an administrator or receiver appointed, do not call on bank guarantee security, exercise another right or purport to terminate the contract without seeking legal advice from a firm like ours. |
Other avenues could be available to you to manage your risk. Rushing without advice may prove costly, with the counter party seeking court orders to declare the purported termination void, restrain you from doing so, or exposing your business to damages/liability. |
|
Consider varying existing contracts to include new work/services rather than entering into new contracts with the same suppliers shortly after 30 June 2018. |
The law only applies to new contracts entered into after 30 June 2018, not pre-existing contracts. In limited suitable circumstances, variation rather than entry into new contracts could be explored. |
|
Educate contract administrators and non-legal staff about the application of these new laws to ensure no unlawful steps are taken to terminate or exercise contractual rights which are unenforceable post 30 June 2018. |
Unlawfully purporting to exercise rights that are rendered unenforceable under the new laws from 1 July 2018 may expose you to liability to your counterparty. |
Relevance of these new laws should not be underestimated.
Our legal team has acted for many corporate clients who have unexpectedly encountered insolvency of contractual counter-parties over the past few years, particularly in the construction and services sector.
Recovering distressed projects or substituting the contractor with a new counterparty will not be as straight forward in those same circumstances moving forward, particularly where lengthy breach and cure periods may be required to be waited out before justifying termination for non-performance or where much of the contractor’s/supplier’s performance is occurring off-site and difficult to objectively monitor during an insolvency event.
Major construction and infrastructure projects are a good example of areas that will feel the effects of these new laws harshly. Successful project completion depends on swift responses to risks posed to successful project delivery, particularly if the project is behind schedule. This new law requires much closer management of that risk practically, as the swift trigger of termination of supply and construction contracts due to insolvency events will no longer be available.
If you need assistance in reviewing your contractual arrangements, training your team or developing a plan to manage your risks in light of the above new laws, feel welcome to contact our Adam Merlehan, Jaclyn Riley-Smith or Lai Yee Tan to discuss:
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